Archives

Top Rated

Seed Weekly - An Epic Retirement

My recent experience of completing the Cape Epic has highlighted a number of parallels between the journey to complete the Epic and the journey to retire comfortably. The first similarity is that both endeavours require a detailed plan. When planning for the Epic, we had to plan training programs, nutrition programs, assess our goals, hire support for the race and plan our strategy. When planning your retirement, it is imperative that both Husband and Wife have the same goals and expectations regarding retirement. Lifestyle risk is probably one of the most important risks that we face at retirement. Lifestyle risk is the risk that we will not be able to start at or maintain the lifestyle that we are accustomed to when we reach retirement. Unfortunately, lifestyle risk is affected by a number of factors some people start saving too late, some people don’t save enough and sometimes people don’t have high enough investment returns. All of these factors have an influence in how comfortably we can retire.

Retirement, like the Epic, also can have a longevity risk in the Epic if you take too long, you run out of time and they cut off your number board, in retirement, whilst less dramatic, out-living your capital can have disastrous consequences, this risk has been exacerbated by the number of people taking early retirement and a general increase in life expectancy.

One of the biggest risks in the Epic was the effect of accumulated exhaustion forcing you to abandon or make a stupid mistake. In retirement, the enemy is inflation and the accumulative effects of inflation over a long time (remember that a number of people are in retirement in excess of 30 years).

In life like in the Epic, unexpected things happen and we need to prepare as much as possible, but sometimes we just need to roll with the punches. If you have prepared properly you can overcome a number of unexpected problems. As seen with the recent cabinet reshuffle, life will throw us many curve balls - we need to have a plan that will roll with these punches and ensure the best possible chance of reaching our goal of a comfortable retirement.

Seed Weekly - An Epic Retirement

My recent experience of completing the Cape Epic has highlighted a number of parallels between the journey to complete the Epic and the journey to retire comfortably. The first similarity is that both endeavours require a detailed plan. When planning for the Epic, we had to plan training programs, nutrition programs, assess our goals, hire support for the race and plan our strategy. When planning your retirement, it is imperative that both Husband and Wife have the same goals and expectations regarding retirement. Lifestyle risk is probably one of the most important risks that we face at retirement. Lifestyle risk is the risk that we will not be able to start at or maintain the lifestyle that we are accustomed to when we reach retirement. Unfortunately, lifestyle risk is affected by a number of factors some people start saving too late, some people don’t save enough and sometimes people don’t have high enough investment returns. All of these factors have an influence in how comfortably we can retire.

Retirement, like the Epic, also can have a longevity risk in the Epic if you take too long, you run out of time and they cut off your number board, in retirement, whilst less dramatic, out-living your capital can have disastrous consequences, this risk has been exacerbated by the number of people taking early retirement and a general increase in life expectancy.

One of the biggest risks in the Epic was the effect of accumulated exhaustion forcing you to abandon or make a stupid mistake. In retirement, the enemy is inflation and the accumulative effects of inflation over a long time (remember that a number of people are in retirement in excess of 30 years).

In life like in the Epic, unexpected things happen and we need to prepare as much as possible, but sometimes we just need to roll with the punches. If you have prepared properly you can overcome a number of unexpected problems. As seen with the recent cabinet reshuffle, life will throw us many curve balls - we need to have a plan that will roll with these punches and ensure the best possible chance of reaching our goal of a comfortable retirement.

Seed Weekly - An Epic Retirement

My recent experience of completing the Cape Epic has highlighted a number of parallels between the journey to complete the Epic and the journey to retire comfortably. The first similarity is that both endeavours require a detailed plan. When planning for the Epic, we had to plan training programs, nutrition programs, assess our goals, hire support for the race and plan our strategy. When planning your retirement, it is imperative that both Husband and Wife have the same goals and expectations regarding retirement. Lifestyle risk is probably one of the most important risks that we face at retirement. Lifestyle risk is the risk that we will not be able to start at or maintain the lifestyle that we are accustomed to when we reach retirement. Unfortunately, lifestyle risk is affected by a number of factors some people start saving too late, some people don’t save enough and sometimes people don’t have high enough investment returns. All of these factors have an influence in how comfortably we can retire.

Retirement, like the Epic, also can have a longevity risk in the Epic if you take too long, you run out of time and they cut off your number board, in retirement, whilst less dramatic, out-living your capital can have disastrous consequences, this risk has been exacerbated by the number of people taking early retirement and a general increase in life expectancy.

One of the biggest risks in the Epic was the effect of accumulated exhaustion forcing you to abandon or make a stupid mistake. In retirement, the enemy is inflation and the accumulative effects of inflation over a long time (remember that a number of people are in retirement in excess of 30 years).

In life like in the Epic, unexpected things happen and we need to prepare as much as possible, but sometimes we just need to roll with the punches. If you have prepared properly you can overcome a number of unexpected problems. As seen with the recent cabinet reshuffle, life will throw us many curve balls - we need to have a plan that will roll with these punches and ensure the best possible chance of reaching our goal of a comfortable retirement.

Seed Weekly - Investment Choices

The answer is, “It depends, but probably a Balanced Fund…”

Over the past few years, South African investors have generally been disappointed with their investment returns – and rightly so. Asset class performance has been lacklustre across the board and investors would have needed to do something ‘special’ (read – risky) in order to generate satisfactory returns. As such, many investors now want to put their investment savings into cash or cash like investments. The line of thinking is that cash is low risk (i.e. low chance of losing capital) and will provide returns in line or close to what balanced funds have delivered over the last couple of years.

While cash/very low risk investments do have their place in a portfolio, especially where an investor has a short term savings goal, it is important to ensure that the overall portfolio allocation matches the investor’s investment requirements. For most investors, the bulk of their investments will typically be used to service their income needs in retirement, these investors will therefore have an investment horizon of 5 years plus on the bulk of their assets (even most investors IN retirement will require their savings to last longer than 5 years).

It is therefore interesting to stress test how a ‘5 year horizon strategy’ would have performed over the 2008/9 financial crisis/market crash, which is widely acknowledged as one of the most severe of all time, versus cash. For the purpose of this exercise I have taken the performance of the four largest (most popular) balanced funds in South Africa (funds that sit in the ASISA South Africa Multi Asset category) over the full range of 5 year periods that incorporated the market crash (i.e. 31 May 2008 – 28 February 2009) and compared their performance to what an investor would have received from cash (in both cases before any tax effects – which generally has a greater impact on cash). For completeness sake, this incorporates rolling 5 year periods from 28 February 2004 – 28 February 2009 to 31 May 2008 – 31 May 2013.

When looking at all of the rolling 5 year periods it is evident that these managers have done really well versus cash (STEFI Call). Two managers managed to outperform cash in all rolling periods and the other two outperformed cash 98% of the time (even the average manager outperformed nearly 70% of the time). The chart below illustrates this fact. It is also interesting to note that even with the market crash as part of the observation period these funds in some cases were able to deliver returns in excess of 15% pa and in most cases in excess of 10% pa.

Source: Morningstar 18 April 2017

While it is all good and well to look at the performance after the full period and recognise that it would be a good idea to remain invested through the market stress, it is a much different story in the heat of the moment, i.e. during the market turmoil. I have therefore taken each of the above rolling 5 year returns and shown their return path. This chart (below) gives some sense of the range (208 possibilities) of investor experiences along the way to getting a 5 year annual return of slightly less than cash to a return in excess of 20% pa by investing in a balanced fund.

Source: Morningstar 18 April 2017

To simplify, I have then taken the best, worst, and the middle (median) return from the above and compared these to the same range for cash. As can be seen below, in the worst case scenario an investor into a balanced fund could have experienced a drawdown of 20% over a period of nearly 1.5 years, still been negative after nearly 2.5 years, and only overtaken the worst cash experience right at the end of the 5 year period! More realistically, the average fund investor would have generated a return some 4% pa better than the average cash investor, despite investing through the 2008/9 crash! It is also evident that an investor with a shorter investment horizon (i.e. 1 year or 3 years) should probably be investing into a lower risk option – potentially even cash!

Source: Morningstar 18 April 2017

A bell doesn’t ring at the top of the market, and no one has a crystal ball. For MOST investors it therefore makes sense to match their investment strategy (should ideally be invested into a well-diversified multi asset Fund) with their investment horizon and REMAIN invested through the various market cycles. As has been shown, the opportunity cost of giving up strong returns by moving to cash is generally MUCH higher than the cost of being invested at the worst possible time.

Seed Weekly - First Quarter 2017 Update - Multi-Asset Funds

The year started on a positive note for investors with assets positive over the first quarter, albeit through volatile markets. Local politics again was a major talking point, particularly at the end of the quarter when the cabinet reshuffle led to a fallout and subsequently a credit ratings downgrade to sub-investment grade.

Ian covered the implications of the credit ratings downgrade for investors in his article last week (view article), and further discussed the importance of Multi-Asset Funds in such times. These funds offer diversification benefits through exposure to different asset classes, which helps to soften the blow in volatile markets. Part of our philosophy is managing risk and, as such, Multi-Asset Funds are a key area of focus for Seed.

Asset Class Performance First Quarter 2017

Figure 1: Local Asset Class Performance

Source: Morningstar Direct (11 April 2017)

In spite of the elevated risk levels within the markets, investors enjoyed a fairly good start to the year with the various asset classes ending positive. The politics-induced turmoil at the end of March was not enough to counter the gains over the quarter. Equity was the top performing asset class, the FTSE/JSE All Share Index gaining 3.8% over the quarter. Listed property had the weakest quarter while bonds fared better, benefiting from Emerging Market flows, although understandably slumping at the end of March on politics.

Seed Balanced Fund

Fund Launch : 04 June 2010

Our flagship fund, the Seed Balanced Fund, had a good quarter delivering top quartile (Top 25%) performance relative to peers in the ASISA South African Multi-Asset High Equity category. Figure 2 below illustrates that on a rolling 3-year basis, the Fund has protected capital and outperformed the average of the peer group all of the time since inception (46 out of 46 times). The rolling outperformance has been consistent with the Fund ranking in the top half of the funds 91% of the time, and top quartile 63% of the time. The long-term outperformance is a result of running a diversified portfolio comprising carefully selected uncorrelated strategies which complement each other well.

Over the quarter, the Seed Stable Fund also delivered top quartile performance relative to peers. Figure 3 below illustrates that on a 1 year rolling basis, the Fund has outperformed the average of the peer group 86% of the time (42 out of 49 times). The Fund has protected capital well and ranked in the top half of funds within the ASISA South African Multi-Asset Low Equity category 82% of the time, and 59% in the top quartile. The Fund has also benefitted from carefully selected uncorrelated strategies to manage risk and deliver outperformance.

A long term multi-asset strategy is essential for investors, especially in volatile times when risk is elevated. There are numerous Multi-Asset categories to choose from, and this is a key area of focus for us. We express our best ideas in our portfolios which comprise appropriate uncorrelated strategies, blended together to minimise the risk while optimising returns for investors.

Seed Weekly - Downgrade of South Africa’s Foreign Currency Rating

On Monday, rating agency S&P Global downgraded its rating of South Africa’s long term foreign currency debt to sub-investment grade, commonly known as junk. The rating is now at a BB+. They also have a negative outlook, which means that on their upcoming reviews there is the possibility of a further notch downgrade.

The local currency rating was lowered one notch to BBB-, which is one notch above sub-investment grade.This also is on a negative outlook. We can expect other rating agencies, i.e. Moody’s and Fitch, to follow suit with ratings downgrades.

What does this mean?

Essentially, a downgrade in the rating is an assessment of the increased risk in government being able to meet its fiscal and growth targets, given what S&P described as “policy continuity risk”.

Any borrower who has a substandard credit record can expect to be charged a higher interest rate on borrowings. The same rationale extends to the South African government and all state-owned enterprises. The increased risk, as quantified by a rating agency, ultimately means that investors (i.e. lenders) will demand an additional premium (i.e. higher interest rate).

Bond yields on government bonds have been pricing in this additional risk for some time, but on Tuesday morning, the R186 government bond, having closed at a yield of 9% on Monday, fell to a yield of around 9.2% before edging back to around, and indeed below, the 9% level.

The currency also fell from around R13.50/USD at 5pm to over R13.70/USD, strengthening back again in late Tuesday to around R13.55/USD.

In the short term and indeed over the longer term, the mere fact that government has a weaker rating on its debt is a negative for the economy as a whole because the cost of its debt is higher. This additional cost is ultimately paid by taxpayers.

What does this mean for investors in multi managed, multi asset funds?

We believe that given the level of uncertainty, one of the best options for all investors to consider is a balanced fund. Outlined below is a table reflecting the various asset classes in which the Seed Stable and the Seed Balanced are invested.

Column 2 indicates the overweight or underweight position of the fund. Column 3 indicates the short-term performance (positive, neutral or negative) of Monday’s downgrade decision on these asset classes for local investors.

Source : Seed Investments – 5 April 2017

Some further considerations

The table above reflects that despite the downgrade on the rating, this is not negative for all asset classes. Naturally, as the currency weakens, the result is positive for global investments, range hedge local equities, gold etc.

While the higher cost of debt is negative for taxpayers, for investors the additional interest rate incurred by government on its debt at times more than compensates for the additional risk, and where this is the case, investors would be wise to take advantage. Such was the case for the whole of 2016, where investors in government debt enjoyed a 15.4% gain on their investment. At the same time, foreign investors received a gain as the local currency appreciated from the exceptionally weak January 2016 level.

Conclusion

Investors have typically done well over the past 3, 5 and even 10 years by investing into a balanced fund, such as the Seed Balanced Fund or a multi asset lower equity fund, such as Seed Stable Fund, which exposes the investor to a range of asset classes.

The same is likely to be true in volatile times that we are facing at present.

Seed Weekly - Earnings Jump on the JSE

An important part of Seed’s multi management process is performing monthly asset class valuations using our in-house quantitative models. This process covers all the local and global asset classes that are suitable for inclusion in our multi asset class funds and model portfolios. The output of these models guide our tactical asset allocation decisions, where we under- or overweight certain asset classes in the short term, compared to our longer-term target weights.

Our local equity model has ranked local equity as expensive for around 5 years now, and our models currently indicate that the market is within 6% of most expensive valuations since 1986. One of the inputs of our valuation model is the Price/Earnings (PE) ratio, which is the multiple of annual earnings investors are willing to pay for a certain company, sector or the market as a whole. We have found that the total market PE is not a great leading indicator of stock market returns over the short to medium term, but does give a good indication of what to expect over the long term.

At the end of February, we have seen the market PE ratio come down from an all-time high of 23.5 to a less extreme, but still expensive, 19.8. The market PE ratio can decrease when either company share prices go down, reported company earnings go up, or both. During February, the JSE fell -3.1%, which accounts for some of the -16% drop in PE. We therefore did some further digging to investigate the earnings increase that would account for the rest of the change.

Investigating the PE ratios per sector on the JSE, it is clear that some very strong earnings had come through in the Resources sector, resulting in the PE dropping from 29.3 to 15.5 times. At face value, it seems as if Resources has gone from being as expensive as the Industrials sector to being as cheap as the Financials in a single month.

Chart 2 : Sectors PE Ratios

Source: INET (28 March 2017)

This again highlights one of the pitfalls of using a historic PE ratio – a sector can appear expensive, just because the market already places a premium on strong earnings that have just not been reported yet. As soon as reporting season starts and the higher earnings come through from the data providers, a high company or index PE ratio can unwind very quickly.

Table 1 : Illustration of the resource shares with significant changes in reported Earnings per Share during February

Source: INET (28 March 2017)

Within the Seed Balanced Fund, each of our two local equity managers have a wide mandate and are not restricted to specific sectors or industries. On a sector level, the consolidated local equity exposure within the Fund does not differ vastly from the JSE All Share Index at the moment. The combined portfolio has an active share of 55% with a slight overweight to Industrials, slight underweight to Financials and an on-weight Resources exposure.

Seed Weekly - The Shift to Passive Investing

When it comes to investment management trends, the US tends to lead the world. One trend that started as a trickle to become a raging river is the flow of investment funds away from active managers over to passive fund managers.

In his annual report for Berkshire Hathaway, Warren Buffett has over the past few years continued to endorse the idea of passive investing rather than active investment management. His advice is for investors to rather opt for a low cost S&P500 index fund (i.e. a passive index tracker).

The statistics are proving that in the US at any rate, investors have started to listen to him and others. Morningstar reported, “In the U.S., the gap between active and passive flows has never been wider. U.S. index funds received $492 billion in 2016. Their active counterparts, in sharp contrast, saw $204 billion fly out the door.”

So just what is passive and active?

A passive investment strategy is a fund or investment strategy that merely tries to replicate a certain index as closely as possible over time. Because the constituents and construction methodology of most indices, like the S&P500 index, are made available, a simple strategy is for a portfolio to exactly replicate this.

Active investment management, on the other hand, is a style of investing where the portfolio manager aims to design a portfolio that will outperform the fund’s benchmark or index. The selection of shares and the weight of the shares will therefore differ from the index in attempt to produce a superior result.

The pioneer of index investing in the US is Jack Bogle, founder of the Vanguard Group. This fund manager is now taking the lion’s share of money moving into the passive space. The chart below compares the flow of funds into active and passive strategies over the last 10 years.

Chart 1: Flow of Funds to Active and Passive Managers in the US

Source: Morningstar Direct, 22 March 2017

Multi management is the blending of both asset classes and specialist asset managers within one fund. Therefore, while we discussed the merits of diversification last week, an investor can obtain these benefits within one multi-asset, multi-management fund.

In our opinion, the rise of passive management merely provides more options to a multi-manager when looking to combine different investment assets, funds, and investment styles. A manager can combine the best of both worlds - passive strategies, which aim to extract merely the market return for an asset class at the lowest cost possible, with active strategies that aim to extract additional alpha (i.e. a return above the market).

Active and passive strategies will typically perform differently in different market cycles. Normally, in strong bull markets, as we have witnessed over the last 8 years in global equities, passive strategies will tend to outperform. However, in choppy and sideways markets, often characterised by sector rotation, good active managers will tend to produce superior results.

At the same time, passive strategies can be very specific. For example, on a global scale, there are passive index funds that only comprise healthcare shares, or only IT (information technology) shares. These can be used with great effect within a multi-manager portfolio.

At Seed Investments, we are very positive about the global availability, and increasingly so, local availability of passive investment strategies. The expanding choice is excellent where we are looking to blend different styles and investments with low correlations.

Seed Weekly - Goal Based Investing

A well-designed and thought-out investment strategy is crucial to anyone planning to build wealth.

Designing such a strategy is no small task. Each individual has unique circumstances, preferences and needs. The future remains opaque and forces one to make certain assumptions that may or may not turn out to be correct.

Another stumbling block in the process of designing an investment strategy, is defining risk for an individual or entity. This is, in fact, harder than one may think. Is it loss of capital (permanent or temporary), minimizing volatility, avoiding large drawdowns, missing growth targets, inadequate liquidity? Is it perhaps all of the above? Or a combination of the above? This question becomes even more convoluted if you realize that one's ability and willingness to tolerate risk is often not the same, or even constant, over time.

This makes one wonder if there is any use in undertaking this laborious exercise.

Many say that this is preferable to nothing, which makes sense. Better a rough model that points vaguely in a direction, than stumbling blindly through your investment life-cycle. Of course, we demand more from ourselves as professionals. We don't like uncertainty and believe that vagueness is not an acceptable basis from which to give advice. It is a major task to get this right.

How does one run a marathon? Step by step.

Start by defining your investment goals, and then ranking them. Apply an 'if-then' heuristic starting with the most important goals. If the primary goals are attainable, to a high degree of probability, determine whether the next goal is realistic and move down the ranking table.

If your primary goal is to have sufficient assets for retirement, and you have a number of years to go before drawing on your assets, adopt a long term approach and ensure that you are adequately funding this goal. Don't let a supplementary goal, such as buying a shiny new car, impede you from reaching your primary goal by applying 'short term thinking' to a long term goal.

Long term goals will have a different definition of risk in comparison to short term goals; not meeting growth targets in the long term should be the primary risk factor. Risks such as minimising volatility, liquidity management and drawdown avoidance should not dominate the primary risk factor. You cannot aim for double digit growth without experiencing some volatility. The shorter term the goal, the more emphasis will be placed on the minimisation of volatility, drawdowns and liquidity management.
The above leads one to adopt a goals based investing approach. This approach will have an investment strategy and tranches of committed capital for each goal. We do not make use of this methodology primarily, as it goes somewhat against most efficiency models and theories. Building an efficient portfolio has been deeply ingrained in our approach, and still forms a major part of our process.

Goals based investing helps one to compartmentalise and understand your goals. It is by no means a perfect solution, as it will result in an overall portfolio that is not optimal. It is something we consider a practical measure in simplifying the task of designing your investment strategy, and as such constitutes a part of the process we undertake to properly design your strategy.

Kind regards,

Stefan Keeve

***SEED IS HIRING: Seed is looking to hire an Administrative Assistant on a contract basis. Please click here to view vacancy

Seed Weekly - Fund Management Industry Update

2016 was a challenging year for investors as macroeconomic issues rather than fundamentals, proved to be the key market drivers. Politics in particular, played a key role in markets both locally and globally with key issues around Brexit, the US election and domestic politics.

The challenges within the economy and markets however did not deter local fund managers from launching new products. According to data from Morningstar Direct, 177 new unit trust funds were launched in 2016, with 22 management companies responsible for the launches. As at 31 January 2017, Assets under Management within these funds totalled R37 billion, 85% of which is attributed to only 6 of the management companies. Approximately 68% of the new funds are co-named portfolios.

Figure 1: New Funds launched in 2016 per Association for Savings and Investment South Africa (ASISA) category

Source: Morningstar Direct (3 February 2017)

The majority of the new funds, both in count and assets are locally focussed as illustrated in Figure 1. The Assets under Management of these South African focused funds total R32 billion and the total number of funds is 130. Unsurprisingly, the bulk of the assets are in the ASISA Multi-Asset categories which have seen good growth in recent years. The South African General Equity category also saw significant changes with 25 funds launched with assets of almost R8 billion by the end of January 2017.

Although there was a significant number of new funds, only a relatively smaller number of funds were terminated. Analysis of Morningstar data indicates that approximately 24 funds were terminated. These funds held a combined R4.1 billion in assets at the beginning of 2016. A total of 91 fund classes were liquidated over the year. Furthermore, 9 funds were merged with other funds thereby ceasing to exist in their original form. All in all, 33 fund classes were merged and incorporated into other funds.

The above statistics show that the industry continues to grow and this makes choosing funds for investors even more complicated. It remains important for investors that funds actually deliver performance in line with their investment targets. Absolute performance provides a quick reference point for investors to check if investment objectives are being met. The table below summarises the best and worst performing funds in popular ASISA categories.

Table 1: Fund Performance (% Return) as at 31 January 2016

Source: Morningstar Direct (6 February 2017)

The dispersion in performance between the best and worst performing funds over the last year is quite large. Moreover, some of the winners over the last year were the losers in the last few years with the opposite also true for some of the losers. The dispersion and cycles of performance highlights some of the complexities investors face in choosing appropriate funds to meet their investment objective especially in this growing industry.

At Seed, our process helps us to navigate the fund choice complexities for our clients. We carry out extensive fund and manager research using a combination of industry and proprietary analytical tools, which we couple with our extensive manager experience. With a long-term philosophy, opportunity seeking and risk management mind-set, we are well equipped to assist our clients in meeting their investment targets over the long run.